Forecast | Third industrial revolution to cause a deflation outbreak: Future of the economy P2

Unlike what our 24-hour news channels would like us to believe, we live in the safest, wealthiest, and most peaceful time in human history. Our collective ingenuity has enabled mankind to end widespread starvation, disease, and poverty. Even better, thanks to a wide range of innovations currently in the pipeline, our standard of living is set to become even cheaper and considerably more bountiful.

And yet, why is it that in spite of all of this progress, our economy feels more fragile than ever? Why are real incomes shrinking with each passing decade? And why do the millennial and centennial generations feel so anxious about their prospects as they grind into their adulthood? And as the previous chapter outlined, why is the global wealth divide getting so out of hand?

There’s no one answer to these questions. Instead, there are a collection of overlapping trends, chief among them being that humanity is struggling through the growing pains of adjusting to the third industrial revolution.

Understanding the third industrial revolution

The third industrial revolution is an emerging trend recently popularized by American economic and social theorist, Jeremy Rifkin. As he explains, each industrial revolution occurred once three specific innovations emerged that together reinvented the economy of the day. These three innovations always include groundbreaking breakthroughs in communications (to coordinate economic activity), transportation (to more efficiently move economic goods), and energy (to power economic activity). For example:

The first industrial revolution in the 19th century was defined by the invention of the telegraph, locomotives (trains), and coal;

The second industrial revolution in the early 20th century was defined by the invention of the telephone, internal combustion vehicles, and cheap oil;

Finally, the third industrial revolution, which began around the 90s but really began to accelerate after 2010, involves the invention of the Internet, automated transportation and logistics, and renewable energy.

Let's take a quick look at each of these elements and their individual impact on the wider economy, before revealing the economy-shifting effect they will create together.

Computers and the Internet foreshadow the specter of deflation

(1) Steady, Moore's Law guided advancements are allowing the number of transistors, per square inch, on integrated circuits to double roughly every year. This enables all forms electronics to miniaturize and become more powerful with each passing year.

(2) This miniaturization will soon lead to the explosive growth of the Internet of Things (IoT) by the mid-2020s that will see near-microscopic computers or sensors embedded into every product we buy. This will give rise to "smart" products that will constantly be connected to the web, allowing people, cities, and governments to more efficiently monitor, control, and improve how we use and interact with the physical things around us.

(3) All these sensors embedded into all these smart products will create a daily mountain of big data that will be near impossible to manage if not for the rise of quantum computers. Luckily, by the mid- to late-2020s, functional quantum computers will make processing obscene amounts of data child’s play.

(4) But quantum processing of big data is only useful if we can also make sense of this data, that's where artificial intelligence (AI, or what some prefer to call advanced machine learning algorithms) comes in. These AI systems will work alongside humans to make sense of all the new data being generated by the IoT and enable decision makers across all industries and all government levels to make more informed decisions.

(5) Finally, all the points above will only be magnified by the growth of the Internet itself. Currently, less than half of the world has Internet access. By the mid-2020s, well over 80 per cent of the world will gain access to the web. This means the Internet revolution that the developed world enjoyed for the last two decades will be expanded across all of humanity.

Okay, now that we’re caught up, you might be thinking that all of these developments sound like good things. And by and large, you would be right. The development of computers and the Internet has improved the individual quality of life of every individual they have touched. But let’s look wider.

Thanks to the Internet, today's shoppers are more informed than ever before. The ability to read reviews and compare prices online has caused a relentless pressure to cut prices on all B2B and B2C transactions. Moreover, today's shoppers don't need to buy locally; they can source the best deals from any supplier connected to the web, be it in the US, the EU, China, anywhere.

Overall, the Internet has acted as a mild deflationary force that has leveled out the wild swings between inflation and deflation that were common throughout much of the 1900s. In other words, Internet-enabled price wars and increased competition are major factors that have kept inflation stable and low for nearly two decades so far.

Again, low inflation rates aren’t necessarily a bad thing in the near term as it allows the average person to continue to afford the necessities of life. The problem is that as these technologies develop and grow, so too will their deflationary effects (a point we’ll follow up about later).

Solar hits a tipping point

The growth of solar energy is a tsunami that will engulf the world by 2022. As outlined in our future of energy series, solar is due to become cheaper than coal (without subsidies) by 2022, across the world.

This is a historic tipping point because the moment this happens, it will no longer make economic sense to invest further into carbon-based energy sources like coal, oil, or natural gas for electricity. Solar will then dominate all new energy infrastructure investments globally, in addition to other forms of renewables that are making similarly sizeable cost reductions.

(To avoid any angry comments, yes, safe nuclear, fusion and thorium are wildcard energy sources that may also make a substantial impact on our energy markets. But should these energy sources be developed, the earliest they will come on the scene is by the late 2020s, ceding a major head start to solar.)

Now comes the economic impact. Similar to the deflationary effect electronics and the Internet enabled, the growth of renewables will have a long term deflationary effect on electricity prices globally after 2025.

Consider this: In 1977, the cost of a single watt of solar electricity was $76. By 2016, that cost shrunk to $0.45. And unlike carbon-based electricity plants that require costly inputs (coal, gas, oil), solar installations collect their energy from the sun for free, making the additional marginal costs of solar nearly zero after installation costs are factored in. When you add to this that on an annual basis, solar installations are getting cheaper and solar panel efficiency is improving, we’ll eventually enter an energy abundant world where electricity becomes dirt cheap.

For the average person, this is great news. Much lower utility bills and (especially if you live in a Chinese city) cleaner, more breathable air. But for investors in the energy markets, this is probably not the greatest news. And for those countries whose revenues depend on natural resource exports like coal and oil, this transition to solar can spell disaster for their national economies and social stability.

You’ve likely read all about them in the media these past few years, and hopefully, in our future of transportation series as well: electric vehicles (EVs) and autonomous vehicles (AVs). We’re going to talk about them together because as luck would have it, both innovations are set to hit their tipping points roughly around the same time.

By 2020-22, most automakers forecast that their AVs will become advanced enough to drive autonomously, without the need for a licensed driver behind the wheel. Of course, public acceptance of AVs, as well as legislation permitting their free reign on our roads, will likely delay AVs’ widespread use until 2027-2030 in most countries. Regardless of how long it takes, the eventual arrival of AVs on our roads is unavoidable.

Likewise, by 2022, automakers (like Tesla) forecast that EVs will finally reach price parity with traditional combustion engine vehicles, without subsidies. And just like solar, the tech behind EVs will only improve, meaning that EVs will gradually become cheaper than combustion vehicles each year forward after price parity. As this trend progresses, price-conscious shoppers will opt to buy EVs in droves, sparking the terminal decline of combustion vehicles from the marketplace within two decades or less.

Again, for the average consumer, this is great news. They get to buy progressively cheaper vehicles, that are also environmentally friendly, have far lower maintenance costs, and are powered by electricity that (as we learned above) will progressively become dirt cheap. And by 2030, most consumers will opt out of buying pricey vehicles altogether and instead hop into an Uber-like taxi service whose driverless EVs will drive them around for pennies a kilometer.

The downside however is the loss of hundreds of millions of jobs related to the automotive sector (explained in detail in our future of transportation series), a slight contraction of the credit markets since fewer people will take out loans to buy cars, and yet another deflationary force on the wider markets as autonomous EV trucks dramatically reduce the cost of shipping, thereby further reducing the cost of everything we buy.

Automation is the new outsourcing

Robots and AI, they have become the millennial generation’s boogeyman threatening to make about half of today’s jobs obsolete by 2040. We explore automation in detail in our future of work series, and for this series, we’re devoting the entire next chapter to the topic.

But for now, the main point to keep in mind is that just as MP3s and Napster crippled the music industry by bringing down the cost of copying and distributing music to zero, automation will gradually do the same to most physical goods and digital services. By automating ever greater portions of the factory floor, manufacturers will gradually decrease the marginal cost of every product they make.

(Note: Marginal cost refers to the cost of producing an additional good or service after the manufacturer or service provider absorbs all fixed costs.)

For this reason, we will again emphasize that automation will be a net benefit for consumers, given that robots manufacturing all of our goods and farming all our food can only shrink the costs of everything even further. But as might have guessed, it’s not all roses.

How abundance can lead to an economic depression

The Internet driving frenzied competition and brutal price cutting wars. Solar killing our utility bills. EVs and AVs dropping the cost of transportation. Automation making all our products Dollar Store-ready. These are only a few of the technological advances that are not only becoming a reality but are conspiring to significantly cut the cost of living for every man, woman, and child on the planet. For our species, this will represent our gradual shift toward an era of abundance, a fairer era where all peoples of the world can finally enjoy a similarly affluent lifestyle.

The problem is that for our modern economy to function properly, it depends on there being a certain level of inflation. Meanwhile, as hinted at earlier, these innovations that are dragging the marginal cost of our day-to-day lives down to zero, are, by definition, deflationary forces. Together, these innovations will gradually push our economies into a state of stagnation and then deflation. And if nothing is drastic is done intervene, we could end up in a drawn out recession or depression.

(For those non-economics nerds out there, deflation is bad because while it makes things cheaper, it also drys out demand for consumption and investment. Why buy that car now if you know it will be cheaper next month or next year? Why invest in a stock today if you know it will fall again tomorrow. The longer people expect deflation to last, the more they hoard their money, the less they buy, the more businesses will need to liquidate goods and lay off people, and so on down the recession hole.)

Governments will, of course, try to use their standard economic tools to counteract this deflation—in particular, the use of ultra-low interest rates or even negative interest rates. The problem is that while these policies have positive short-term effects on spending, using low-interest rates for extended periods of time can eventually cause toxic effects, paradoxically leading the economy back into a recessionary cycle. Why?

Because, for one, low-interest rates threaten the existence of banks. Low-interest rates make it difficult for banks to generate profits on the credit services they offer. Lower profits mean some banks will become more risk averse and limit the amount of credit they loan out, which in turn squeezes consumer spending and business investments overall. Conversely, low-interest rates may also encourage select banks to engage in risky-to-illegal business transactions to make up for the lost profits from normal consumer bank lending activity.

Likewise, prolonged low-interest rates lead to what Forbes’ Panos Mourdoukoutas calls "pent-down" demand. To understand what this term means, we need to recall that the whole point of low-interest rates is to encourage people to purchase big ticket items today, rather than leave said purchases to tomorrow when they expect interest rates to go back up. However, when low-interest rates are used for excessive periods of time, they can lead to a general economic malaise—a "pent-down" demand—where everyone has already racked up their debt to purchase the expensive things they planned to buy, leaving retailers to wonder who they will sell to in the future. In other words, prolonged interest rates end up stealing sales from the future, potentially leading the economy back into recession territory.

The irony of this third industrial revolution should be hitting you now. In the process of making everything more abundant, of making the cost of living more affordable for the masses, this promise of technology, all of it may also lead us to our economic ruin.

Of course, I’m being overdramatic. There are far more factors that will impact our future economy both in positive and negative ways. The next few chapters of this series will make that abundantly clear.

(For some readers, there may be some confusion over whether we are entering the third or the fourth industrial revolution. The confusion exists due to the recent popularization of the term ‘fourth industrial revolution’ during the 2016 World Economic Forum conference. However, there are many critics who actively argue against the WEF’s reasoning behind creating this term, and Quantumrun is among them. Nonetheless, we linked to the WEF’s position regarding the fourth industrial revolution in the source links below.)